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The Securities and Exchange Board of India (Sebi) and the income-tax department are investigating the role of about 100 brokerages which they believe may have helped shell companies launder as much as Rs16,000 crore by compromising so-called know-your-customer (KYC) norms, said two people with direct knowledge of the matter.

This is part of an ongoing probe into shell companies by the ministry of corporate affairs, which has identified some 16,000 potentially bogus firms after drawing inputs from the Serious Fraud Investigation Office, Central Bureau of Investigation and Enforcement Directorate, these people said. The 331 firms that Sebi branded as suspected shell companies on 8 August were part of this list. Out of the 16,000 firms, some 10,000 were flagged by the income-tax department.

Sebi did not respond to emails seeking comment. A central board of direct taxes spokesperson did not respond to phone calls seeking comment.

The government has identified shell companies as a key target in its campaign against black money and at least 162,000 firms have been deregistered, finance minister Arun Jaitley said on 21 July.

Shell companies are ones that do not have any legitimate business and are used only for tax evasion and money laundering.

The brokerages played a key role in allowing these shell companies to trade in listed penny stocks and show illegal wealth as trading profits, one of the two people said.

“Some Kolkata-based brokers have themselves created front companies. In some cases, entry operators (middle men who facilitate deals) have been allowed to open bogus companies and client accounts with brokers. For allowing shell companies to trade, the brokers take a cash commission," added this person.

While this is an initial alert list, the regulators are approaching it with caution.

“Not all brokerages in the list are operating out of malafide intent. In some cases, it is officials in regional offices who have circumvented the law by compromising KYC norms and failure to do proper due diligence on clients. So, it could be lack of systems," said the second person.

Sebi’s caution also arises from the fact that the capital markets regulator’s 8 August order had to partially reversed after some of the banned companies approached the Securities Appellate Tribunal (SAT) for relief. SAT allowed eight of these companies—Parsvnath Developers Ltd, Kavit Industries Ltd, Kkalpana Industries (India) Ltd, SQS India BFSI Ltd, Pincon Spirit Ltd, Signet Industries ltd, J. Kumar Infraprojects Ltd and Prakash Industries Ltd—to resume trading. The regulator has asked exchanges to verify credentials of over 100 out of the 331 firms.

“In the board meeting on 18 September, Sebi will also take stock of the brokers involved in these activities," the second person added.

Sometimes, brokers may not know they are dealing with a shell company, a tax expert explained. “It is no secret that there are certain front companies created to hide black money. There could be cases where brokers are hand in glove with operators to create such companies to launder money, but it may not be true in all cases. By the time a structure is created, a company would have all its records in place and from a KYC stand point it would be difficult for a broker to identify genuine companies from bogus ones," said Vikas Gupta, partner, Nangia and Co Llp.

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